Falling off a 'fiscal cliff'

US politicians are debating tax rises and spending cuts but are the doomsday scenarios being evoked credible?

As Congress returned to work on Monday following the Thanksgiving break, attention focused on efforts to reach a deal to prevent the country falling off a so-called 'fiscal cliff'.

Washington consensus says a failure to reach a deal over automatic year-end spending cuts and tax break expirations will be disastrous for an already fragile US economy.

"There's a certain genius to the buzzword, to the phrase-making that was developed here to create the impression of a great crisis by the end of the year. But in fact, if no compromise is reached then things will evolve in the new year very gradually and any pressure that is felt on the economy will probably not be visible for months. And there is plenty of time for the new Congress to deal with it."

- James Galbraith, from the University of Texas

All of the Bush-era cuts are due to expire as well as President Barack Obama's two per cent payroll tax reduction from 2010.

These increases would bring in an additional $400bn next year. In addition, $100bn would be raised through cuts to federal expenditure, including unemployment benefits, Medicare and military spending.

Though this will help reduce the deficit, Congressional economists warn that the US may also be plunged back into recession as a result.

The term 'fiscal cliff' was coined by Ben Bernanke, the Federal Reserve chairman. It refers to a series of tax rises and spending cuts that will go into effect if Congress does not act.

The sequester is also looming - $65bn in automatic cuts to be implemented across most federal programmes, starting on January 1.

It was mandated by a budget deal in August 2011, which ended the Congressional standoff over the nation's debt limit.

In September, the non-partisan Congressional Research Service (CRS) released a report examining tax rates and economic growth in the US since 1945.

It found that lowering the top tax rates had little or no association with additional investment or economic growth.

Republicans were outraged that the findings ran counter to the underpinnings of their economic argument and the CRS was pressured into withdrawing the report. The findings, nonetheless, survived and were widely circulated.

The report pointed out that, in the 1950s, the top marginal tax rate was above 90 per cent, and the real gross domestic product (GDP) growth rate averaged 4.2 per cent.

By 2012, the top marginal tax rate had dropped to 35 per cent, and the average GDP growth rate had dropped to 1.7 per cent.

"This phraseology of the cliff really does expose kind of the fraudulent nature of the entire conversation because Washington's establishment has been pushing for deficit reduction for two years, at least since the Tea Party took over. Now all of a sudden, here we have a tonne of deficit reduction happening, over the course of next year, and they say: 'well, no, this is a crisis' .... I thought that the crisis was created by this so it exposes kind of the incoherence of the deficit talks."

- Ryan Grim, the Washington bureau chief for The Huffington Post

The report said lowered tax rates for the highest earners only served to concentrate wealth in their hands.

Although real income for the average American has increased by 116 per cent since 1945, for the top 0.1 per cent, real income has increased by 395 per cent.

And for the top 0.01 per cent, real income has increased by 692 per cent over the same time period.

Many progressive economists argue that the terms of the whole debate are phony and that Democrats should stand their ground, not yielding to pressure to agree to cuts to social programmes in search of a desperate bipartisan compromise.

Since the election, there have been signs that such a compromise may be reached. Some senior Republicans, including the South Carolina Senator Lindsey Graham, are disavowing pledges to oppose tax increases.

Obama has also repeatedly signalled a willingness to reach a deal. The question is how far will he go?

Inside Story Americas asks: How severe is the 'fiscal cliff' crisis?

To answer this, presenter Shihab Rattansi, is joined by guests: James Galbraith, a professor of government at the University of Texas; Ryan Grim, the Washington bureau chief for The Huffington Post; and Bruce Fein, a former senior adviser to Ron Paul when he ran for the Republican presidential nomination.

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